Survey results indicate that multiple rules are applied simultaneously in the budgeting process. But their application seems to vary across companies and over time (Mitchell 1993). Hence, we want to understand under which conditions the three major classes of budgeting methods are more preferred.
Empirical studies about budgeting methods choice behavior are scarce and thus the insights about factors which influence the application of budgeting rules are limited. In this study, we want to shed some light on this issue by studying the impact of four potential key drivers: (1) market concentration as a measure of competitive intensity, (2) the time in the market as a measure for life cycle, (3) the order of entry of a product, and the (4) patent status which is very important in pharmaceutical markets as a patent expiration changes the competitive situation dramatically (Fischer, Leeflang and Verhoef 2010).
3.1 Sales-oriented methods
Market concentration. Highly concentrated markets are dominated by only a few large
which generally have to manage a broad portfolio, need some key indicators, such as sales, to make the complex allocation decision manageable. Instead, the allocation decision of companies in less concentrated markets, which are predominantly small companies, are highly influenced by top management decisions and therefore rely more on their managerial judgment. For this reason, we assume that sales-oriented methods are rather preferred by companies in highly concentrated markets.
Stage in life cycle. Due to lower expected profits in the future, products in the later stage of
the life cycle are focused more on cost recovery than on claiming a market position which promises high future potential. Thus, we expect a higher preference for the application of sales-oriented budgeting methods in the later stages of the product life cycle.
Order of entry. As later entrants have to compensate brand disadvantages, they cannot focus
as much on cost recovery as pioneers can. This may reduce the preference for the application of sales-oriented methods for later entrants. So we expect that the preference for the application of sales-oriented budgeting methods is higher for pioneers.
Patent status. A factor of particular importance in the pharmaceutical industry is the patent
status. Patent protection avoids generic entry so that firms are less threatened by competition and may have a stronger focus on cost recovery. Therefore, we expect that the preference for the application of sales-oriented budgeting methods is higher when the product is patent protected.
3.2 Competition-oriented methods
Market concentration. Previous studies show a higher degree of relational behavior in more
concentrated markets (e.g., Ramaswamy, Gatignon and Reibstein 1994). This effect has been explained by a higher threat of competitive moves for the few large firms competing in a highly concentrated market which results in a higher competition orientation in budgeting (Besanko et al. 2007). Consequently, we expect that competition-oriented budgeting methods are more preffered in concentrated markets.
Stage in life cycle. Pharmaceutical products follow a life cycle (e.g., Fischer, Leeflang,
Verhoef 2010). In the early stages of the life cycle, it is of particular importance to create awareness and to obtain distribution channels (Ailawadi, Farris and Parry 1994). Companies need to get a fixed share of voice in the market to achieve market penetration which may result in a stronger competitive orientation. But in later stages of the life cycle the degree of competition increases due to slower market growth or downturn which complicates the
defense of the own market position. This results in an increased focus on competition. Because of these contradicting effects we cannot predict the impact of life cycle effects on the preference for competition-oriented methods and consider it as an empirical issue.
Order of entry. Studies of pharmaceutical markets identified time advantages of pioneers as
well as a higher return of marketing for early entrants due to habit persistence of doctors keeping them by the same drugs, which are most likely pioneer drugs (Coscelli 2000). This allows early entrants a stronger focus on their own business. In addition, due to these effects early entrants generally become dominant player with greater market shares and larger marketing budgets (Berndt et al. 1995) so that the threat due to marketing activities of later (and smaller) entrants is rather low. Contrary, late entrants face brand disadvantages compared to pioneers which they need to compensate in order to improve their position in a mature market. This demands an increased focus on competitors to be able to oppose competitive campaigns. Thus, we expect an increase in application of competition-oriented methods for later entrants.
Patent status. The loss of patent protection in pharmaceutical markets allows for generic entry
which results in a significant increase of competition intensity. This threat of rising competition may strengthen the focus on competitive activities. Contrary, an increase in price elasticity due to generic entry decreases the threat of competitive marketing because in a market of highly comparable products the price becomes the most important driver. As a result of these opposite effects we cannot provide a prediction about the effect of patent status on the application of competition-oriented methods.
3.3 Profit-oriented methods
Market concentration. Profit-oriented methods need to solve a complex profit maximization
problem which has to take account of several factors, such as competition. Due to less competitiveness in highly concentrated markets profit maximization is easier to achieve (e.g., Fischer et al. 2011) so that the allocation solution derived from profit-oriented methods is less complex and more reliable. Further, previous studies indicate that companies in highly concentrated rather fulfill the prerequisites for sophisticated budgeting because they are by definition, on average, larger. They obtain more data which is necessary for estimation of quantitative models, and they possess the operations departments, which are necessary for the development of analytic methods (Patti and Blasko 1981; Lynch and Hooley 1987; Hung and West 1991). Finally, as companies in concentrated markets are generally characterized by a larger variety in the product portfolio the need for sophisticated budgeting approaches like the
profit-oriented methods increases. For all of these reasons, we expect a more intense application of profit-oriented methods in higher concentrated markets.
Stage in life cycle. While in the beginning of the product life cycle managers mainly focus on
improving their market position, this focus changes to exploiting the product’s profit potential, i.e. maximizing profits, in later stages of the life cycle (e.g., cash cows). Further, a reliable estimation of the marketing performance, which is a prerequisite for the application of profit- oriented methods, is rather possible when products stay in the market for a longer time period and a larger database is available. For these reasons, we expect that the preference for applying profit-oriented budgeting methods is higher in the later stages of the product life cycle.
Order of entry. Later entrants suffer from brand disadvantages when entering a market. To
overcome these weaknesses in competition, they are not able to focus as much on profit maximization than pioneers. Contrary, early entrants benefit from time advantages leading to a larger marketing responsiveness and a superior market position (Coscelli 2000). Hence, pioneers are much more focused on profit maximization because they have a larger knowledge about own marketing performance and the resources necessary for sophisticated budgeting, such as “Objective and Task”. Therefore, we expect that the preference for the application of profit-oriented budgeting methods is higher for pioneers.
Patent status. We see an increase in competition intensity due to patent expiration which may
enhance the need for sophisticated budgeting methods, such as “Objective and Task”. But simultaneously, lower profit margins after patent expiration reduce the market attractiveness significantly so that the benefit of the application of profit-oriented budgeting is decreasing. These opposite effects do not allow for a prediction on the effect of patent expiration on the application of profit-oriented methods.
3.5 Summary
We provide a summary of the expected effects of our included determinants on the choice of budgeting methods in Table 2. Herein we also report the operationalization of these variables which we discuss in the next section in more detail.
We do not expect that the preference for the different budgeting rules is stringent substitutive, i.e. there may be arguments which may provide reasons for the application of all three of the budgeting rules included in our study. Further keep in mind, that there are still some rules, in section 2 named as other rules, which are not considered in our empirical analysis.